Whitney Tilson’s Big K12 Short: Criticism Isn’t Stopping Him

Whitney Tilson is attempting to clarify questions related to his big short of K12 Inc. (NYSE:LRN). Specifically, some have claimed that Tilson has a conflict of interest related to his short. Below is his latest from Tilson sent to ValueWalk via email. See more from Tilson on the company here and here.

Whitney Tilson

Courtesy of Kase Capital

Via Whitney Tilson

I’ve had many conversations with various folks about K12 since I went public last week with my presentation about it (which I continue to update regularly – the latest version is always posted at:www.tilsonfunds.com/K12-Tilson-9-17-13.pdf; also, the article I published is posted here).

 

Two of my friends wrote the following: “You have an ineradicable conflict of interest on this one.”And “I think you lost the moral high ground when you shorted the stock. I wish you had stuck to your role as a reformer on this one.”

 

I’m glad they told me this because I’m sure many others have similar feelings and I’d like to address them.

 

While I do much more investing on the long side, I’ve also been shorting stocks in the funds I manage for more than a decade.

 

I’m well aware of the widespread perception that it’s vaguely nefarious and un-American to bet against a company – and even worse to publicly speak out against a company. If you stop and think about it for a moment, however, you’ll quickly realize how foolish this viewpoint is. Healthy markets need a vigorous debate about the level of the market overall as well as the valuation and prospects of specific sectors and companies. Imagine the bubbles that would form if everyone only said and thought positive, bullish things. In fact, you don’t have to imagine this at all: just look at two of the biggest bubbles and busts in history just in the past 15 years – among internet stocks and the housing/debt bubble – and the horrific consequences. I would argue that had there been more skeptics (like me) who were warning – it turns out, 100% accurately – about these bubbles, they wouldn’t have grown as large and the aftermath wouldn’t have been so painful.

 

So now let’s turn to: a) my short position in K12’s stock in the funds I manage in my day job as a hedge fund manager and; b) my public criticism of the company, in part using my platform as an ed reformer (my night job). Is my friend right that I have “an ineradicable conflict of interest”? Absolutely! But isn’t it funny how nobody ever points out that the management and board members of K12, who own tens of millions of dollars of K12 stock and are regularly granted copious amount of stock options, have a conflict of interest as well?

 

In fact, their conflict of interest is exponentially larger than mine. They stand to reap millions of dollars if the stock goes up – far more than I would gain if the stock goes down. And this is only one of dozens of investments in my funds (while it’s my biggest short, it’s only a bit over a 3% position), so whether K12’s stock continues to rise or collapses (as I expect), it is not going to have a meaningful impact on my business or life. In contrast, if K12 is, to quote Jeff Shaw, the former head of K12’s Ohio Virtual Academy, “a house of cards that is going to collapse,” this would have an enormous financial impact on the senior executives at the company, could cost them their jobs, lead to them being investigated, etc. So let’s be clear: they have far more incentive to try to put lipstick on this pig than I do to point out that it is, in fact, a pig.

 

But what about my other friend’s comment that I “lost the moral high ground” when I shorted the stock and that I should have “stuck to [my] role as a reformer”? To answer this question, allow me to give you the timeline. I first shorted K12’s stock more than 16 months ago in May 2012, periodically added to the position over the next year, and haven’t traded in it at all since May of this year. As with most of my short positions, I didn’t disclose or discuss my K12 short position until two weeks ago.

 

So what changed and led me to go public? The answer is simple: I spoke for the first time with a former K12 employee (Jeff Shaw) two weeks ago and since then have spoken with a number of other former employees and others who know the company well. These conversations, in turn, led me to do even deeper research into the company’s business practices, academic results, etc.

 

I struggle for words to describe my feelings about what I’ve found. Horrified doesn’t begin to express it. I already believed that K12 was doing some bad things – that’s why I was short the stock – but when I really started digging, I discovered that things were far worse than I’d realized: the student churn, the way the company increasingly targets the most at-risk kids even though it knows that nearly every one of them is sure to fail, the likely bilking of states via enrollment fraud, the way it effectively controls many of the nonprofits that have been granted charters and siphons all of the profits out of them, the buying of politicians, etc.

 

But worst of all are the academic results. I’ve never seen anything like it. The numbers at every K12 school I’ve seen make the old Locke HS in LA – once the most notorious high school in America before Green Dot took it over – look like Stuyvesant! Look at the data from Tennessee in my presentation (pages 49-50), which shows that the students at the K12 school had less academic growth by far than all 1,300 other elementary and middle schools in the state):

 

 

Or consider Ohio, where the state recently reported that the six biggest cyber schools in the state all got Fs on their state progress reports, with OHVA doing worst of all. The state counts a progress score of -2 as a complete failure for a school – and OHVA’s score was -27! Here’s a chart from the article below:

 

Having become convinced that K12 has run amok and is doing real educational damage to tens of thousands children every year – and giving our entire movement a huge black eye – what was I supposed to do? Remain quiet? Ha! Cover my position before going public so people wouldn’t criticize me for my conflict of interest? What would my investors think of that? I did a ton of research, made an investment based on my conclusions from that research, and then I’m supposed to get rid of that investment because someone might criticize me? Ha!

 

To be clear: I am not bearish on K12 because I am short the stock. Rather, I am short the stock because I am bearish on K12. Anyone who knows me knows that I’d be saying and doing exactly the same things whether or not I had any position in the stock. But I know I’ll be criticized nevertheless. So be it. I’m used to taking plenty of slings and arrows…

UPDATED: 8:29PM EST More on this topic via Whitney Tilson’s education blog

 

QUADRUPLE STOP THE PRESSES!!! (I think I’ve never gone beyond triple, so I’m breaking new ground!)

 

I just posted an article on Seeking Alpha, An Analysis of K12 and Why It Is My Largest Short Position(posted at: http://seekingalpha.com/article/1707192-an-analysis-of-k12-and-why-it-is-my-largest-short-position), which is a follow-up to my presentation that I sent around last week (an updated version of it is posted at www.tilsonfunds.com/K12-Tilson-9-17-13.pdf; I’ve added more than a dozen slides to what I presented last Tuesday, with lots of interesting new material).

 

As I hoped, by publicizing my analysis and critique of K12, a number of people who know the company well have contacted me. Suffice it to say that when I gave my presentation last Tuesday, I was 99% certain that my assessment of K12 was correct, but after hearing from them, I’m now 100% certain.

 

Their overall feedback can be summarized as:

 

1)      Everything in my presentation is correct, but:

 

2)      K12’s bad acts and the harm it’s doing to students are even worse than I documented; and

 

3)      K12 and its online peers are able to continue their bad acts thanks in part to education reformers (myself included), who have remained silent as the online charter school sector has completely run amok, resulting in an ongoing (and rapidly growing) educational catastrophe for hundreds of thousands of kids every year (K12 alone had average student enrollments of 117,563 as of June 30th, making it more thantwice the size of KIPP).

 

(Note that my critique is specifically of K12, not all online charter schools, for-profit charter schools or blended learning schools. While I think the online charter school sector has, overall, run amok, there are a small number of good online schools – and a few students at even the worst online schools are doing well.)

 

Here are quotes from people I’ve spoken with just this week:

 

·         “I met with Ron Packard years ago and could tell his motivations had little to do with kids, everything to do with manipulating state regulation to protect his interests. I started digging into the results, the business model, the organization, and discovered much of what you lay out in detail in your presentation. As I said, they are terrible and epitomize everything that we should be working against in the ed reform movement.”

 

·         “You’re totally right about K12 and, on top of it, they lie all the time. It’s naïve to trust anything they say. So I’m not sure if their schools can be fixed, at least under the company’s current leadership. There’s no such thing as a successful online school in the entire country. To be sure, it works well for some students, but I’d guess only 15% of the ones cyber charters are currently serving.”

 

·         “I know the company very well and your presentation rings true. They have a well-deserved terrible reputation.”

 

I’m embarrassed by my own ignorance and silence on this issue, so I’m determined to make up for this by using my bully pulpit to get the word out to my fellow reformers that we need to immediately end our collective silence for two reasons:

 

1)      It is morally unconscionable and rank hypocrisy to say we care about kids and fight for every child to get a high-quality education – yet fail to recognize and act when bad actors in our movement lure more and more kids into schools to which they are completely ill-suited, where students are almost certain to fail and suffer a major educational setback; and

 

2)      K12 and its ilk are giving the entire reform movement a bad name. They have cleverly positioned themselves as champions of charter schools, parental choice, and blended learning, with the result that their terrible schools and various bad acts give our enemies endless fodder to attack us and drag us all down.

 

Consider Pennsylvania, which has more students (35,000) in online charter schools than any other state. As I show on pages 51-52 of my presentation, the academic results of these schools are dismal. CREDO concluded: “In both reading and math, all 8 cyber schools perform significantly worse than their traditional public school counterparts.” 35,000 mostly failing kids is a big number, which rivals some of the biggest districts in the state. Yet do we reformers turn a blind eye to 35,000 failing kids in a regular district? Of course not! So why are we doing so in the online charter schools “district”?

 

If you favor charter schools, giving parents more choices, and using technology to give kids a better education at a lower cost (as I do), you should be fighting (as I am) to get rid of BAD charter schools, BAD choices for parents, and BAD use of technology to miseducate kids.

 

So why isn’t this happening? Why have reformers been so silent? Think there are six answers:

 

1)      Ignorance. I’ve had my finger on the pulse of the education reform movement for more than a decade – but, as I’ve come to realize, not the entire movement. I hang out with the nonprofit/TFA/KIPP types and know very few people in the for-profit ed sector. Among most people like me, online charter schools aren’t even on the radar screen. (This is also perhaps in part due to the fact that the online charter sector was very small until quite recently.)

 

2)      Genuine belief (mostly rooted in ideology). Many folks love the concept of online charter schools for various reasons: they’re nonunion, aren’t controlled by “The Blob”, are lower cost, further parental choice, and the technology is very cool (the wave of the future!). And K12 is very clever in spinning all negative reports to make it seem like they’re isolated incidents and/or politically motivated. So if you’re predisposed to believe the online charter school story (and don’t look hard at the evidence), it’s easy to believe.

 

3)      They seem like friends. At first glance, K12 champions the same things we champion (expansion of, more funding for, and less red tape for charter schools, parental choice, blended learning, etc.), plus the unions really hate them, so they must be our friends, right?

 

4)      Political necessity. We reformers are almost always outmanned, outspent, and outgunned at least 10:1 by the unions and their lobbyists in the school boards, city councils, and state legislatures around the country. So when K12 shows up with a lot of money and an army of lobbyists and offers to join us in our fight for better funding for charters, etc. (and against various poison pills the unions are always trying to get passed), are we really going to say no because the charter school bill we like has a little part of it that allows online charters unchecked growth, little or no accountability, and more funding?

 

5)      Concern about the movement. K12 has been so clever in wrapping themselves in the major reform issues noted above that many reformers worry that if we attack K12, our enemies will use this to hurt other, good aspects of our movement.

 

6)      Money. K12 has been very clever in cultivating reformers and reform organizations, offering a lot of money, conference sponsorships, etc. You know the old saying: “Whose bread I eat, his song I sing.” It’s exactly what the teachers unions do to win support from groups like the NAACP.

 

In my view, taking this money from K12 is blood money. To any of my friends who are working with and/or taking money from K12, let me put it to you this way: if Randi Weingarten offered you a similar amount of money, lobbying support, etc. in exchange for selling out at-risk kids trapped in failing schools, would you take it? Of course not – you’d be outraged that she’d think you were so unprincipled to even dare to make such an offer. So why are you doing exactly this with K12, selling out over 100,000 kids, an increasing number of whom are at-risk, most of whom are getting a worse education than even the worst bricks-and-mortar school???

 

Folks, better late than never, we need to quickly regain the moral high ground and cut this cancer out of our movement.

 

Best regards,

 

Whitney




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